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China comes of age but faces growing pains

China and its insatiable appetite for energy have been in the headlines since the current global commodities boom got under way in late 1999.

Chinese authorities have been quick to shift at least part of the blame for record high prices to the US - which is, after all, the world's largest consumer of oil, buying up one out of every four barrels on the global market.

China's share of global oil demand has grown steadily from 6% in 2000 to 9% by 2007.

Nonetheless, China now appears to be acknowledging its role in the global market and is starting to come to terms with the attendant responsibilities this entails, including environmental protection at home and the need to balance cooperation with competition for energy resources abroad (see table of selected Chinese overseas investments).

China can look back with pride at its success in pulling the world's most populace nation out of poverty to the threshold of becoming a fully developed economy within the span of twenty years, culminating in the hosting of the Olympic Games in 2008.

Although in cultural terms, China is a mature country with an unbroken history that could rival that of any other nation, in economic terms, it is more like a teenager. And like all teenagers, it has its share of growing pains.

These include the obvious issues of environmental degradation and inflation, but they also include more subtle issues, such as deciding on the proper pace and scope of domestic market reforms.

The course that China plots as it struggles with these issues will become increasingly important to the world at large.

China's domestic market exerts tangible effect on US

Until recently, the US markets were fairly indifferent to events in China, but in an increasingly multipolar world order events in China's domestic market now exert a tangible effect on the US and the global market at large.

This fact was brought to the forefront in June when benchmark US oil futures contract prices on the NYMEX dropped by almost $5 per barrel overnight after the Chinese government announced an increase in domestic gasoline and diesel prices (see chart of NYMEX WTI Crude, June 2008 b/d).

The global markets interpreted this move as a signal that China was making an effort to rein in surging demand, now a key driver of the global markets.

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The underlying cause of this relational shift is simple: two decades of break-neck economic growth has added up to a larger slice of the global energy demand pie.

Indeed, China's share of global oil demand has grown steadily from 6% in 2000 to 9% by 2007, adding some 3-million b/d of new demand to the world during that period, equivalent to India's current consumption, according to estimates by BP.

The blame game

While the US points to China as one of the biggest culprits behind runaway prices in recent years, Chinese authorities say that the US is more to blame, as US demand levels dwarf those of China.

Indeed, while China accounted for 9% of global oil consumption in 2007, the US represented a quarter of the global pie, a whooping 21-million barrels per day our of the world total of 85-million b/d.

But this argument overlooks a basic fact of market dynamics: prices are determined at the margin, that is, by incremental demand, as opposed to absolute demand levels.

While the US is far larger than China in terms of its share of absolute global energy demand, the picture looks dramatically different when comparing their respective shares of annual global demand growth.

Based on recent estimates by the International Energy Agency, China is expected to account for the lion's share of global demand growth this year, or 36%. The US, in contrast, is roughly flat (see chart: China accounts for the largest share marginal global demand).

In the final analysis, China is only part of a larger constellation of factors behind high global oil prices, but its pivotal importance for the global markets is undeniable.

The real question is not who is to blame for the current demand-driven bull cycle, but how key consumers - the US, China and India - will manage demand in the face of supply uncertainties.

For the US, this means looking for marginal gains in oil substitution and efficiency. For China, this means further rationalizing the domestic energy markets.

Next page: Deregulation critical for China's sustained growth

Created: September 16, 2008

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